Promotion Tournaments in Market Equilibrium

Standard models of promotion tournaments assume that firms can commit to arbitrary tournament prizes. In this paper, a firm's ability to adjust tournament prizes is constrained by the outside labor market, through the wages other firms are willing to offer to the promoted and unpromoted workers. The paper shows that sufficiently patient firms may be able to retain some control over the tournament prizes through a relational contract, but if the firms are competitive, full efficiency does not obtain in equilibrium even for discount factors arbitrarily close to one. Full efficiency, however, may be feasible in firms with supranormal profits (monopolistic firms). The paper also shows that a minimum wage regulation distorts the workers' investments in human capital by restricting the firms' abilities to design efficient promotion tournaments. A minimum wage thus leads to underinvestment in competitive firms, but could lead to excessive human capital accumulation in monopolistic firms.Promotion tournaments, Relational contracts

Costly External Finance and Investment Efficiency in a Market Equilibrium Model

The corporate finance literature suggests that a financially constrained firm invests less than an identical unconstrained firm. This does not imply that financial frictions cause firms to invest less than they would in a frictionless economy. When firms compete for investment funds, an increase in financial frictions can lead individual firms to increase their investment levels. A greater than the frictionless level of investment is likely in low productivity firms, in cash-rich firms, and in firms with cheap external capital. Government programs that make capital cheaper for small firms may lead to lower levels of investment for all firms and decrease efficiency.Financial Frictions, Investment distortions

Why Doesn´t Development Always Succeed? The Role of a Work Ethic

This paper presents a theory of underdevelopment. It explains why developing countries may not be able to successfully implement the productive technologies or modes of organization used in developed ones. It also suggests ways around this problem of implementation, and provides an explanation for why already developed countries did not face the same problems. The paper examines the interaction between the population’s work ethic and the actions of firms, where a person’s work ethic comes to matter. It is shown that an economy can be in either a high work ethic steady state, or a welfare dominated low work ethic one. Development makes the high work ethic steady state more e¢cient, but, if too rapid, will not allow it to be reached. Instead, the unique trajectory is to the low one, and welfare is reduced.

Subjective Evaluations with Performance Feedback

This paper models two key roles of subjective performance evaluations: their incentive role and their feedback role. The paper shows that the feedback role makes subjective pay feasible even without repeated interaction, as long as there exists some verifiable measure of performance. It also shows that while subjective pay is helpful, it cannot achieve full efficiency. However, fully efficient incentives are achievable if the firm can commit to a forced distribution of evaluations and employs a continuum of workers. With a small number of workers, a forced distribution is valuable only if the verifiable measure is poor.Subjective Evaluations, Performance Feedback, Optimal Contracts

A Rent Extraction View of Employee Discounts and Benefits

We offer a novel view of employee discounts and in kind compensation. In our theory, bundling perks and cash compensation allows a firm to extract information rents from employees who have private information about their preferences for the perk and about their outside opportunities. We show that in maximizing profit with heterogeneous workers, the firm creates different bundles of the perk and salary in response to different employee characteristics and marginal costs of the perk. Our key result is that strategic bundling can lead firms to provide perks even in the absence of any cost advantage over the outside market and to deviate from the standard marginal cost pricing rule. We study how this deviation depends upon the set of feasible contracts, upon the perk's marginal cost, and upon the correlation between the agents' preferences for the good and their reservation utilities.In Kind Compensation, Bundling, Optimal Employment Contracts

Culture and Development: An Analytical Framework

This paper develops a framework which analyzes how a population's culture affects the decisions of rational profit maximizing firms, while simultaneously exploring how the actions of these firms in turn affect the population's culture.By endogenizing culture as well as the more usual economic variables, it shows how an economically valuablebehavioural trait can be sustained as part of a competitive equilibrium.It is shown that, for given primitives, an economy can be in either a 'good' steady state, in which the valuable cultural trait is present, or a welfare dominated 'bad' one in which the valuable cultural trait disappears.Starting from the 'good' steady state and implementing productivity improvements raises welfare, but if changes are too rapid this steady state will not be reached from the old one.Instead, the unique trajectory is to the bad steady state where welfare is reduced.culture;development;inequality;technological change

Durable Goods Monopoly, Learning-by-doing and "Sleeping Patents"

We analyze a durable good monopolist's decision to adopt a new and more efficient technology that is readily available at no cost. After an initial period of learning by doing, the new technology can either lower the cost of production, or make the good more attractive to consumers. We show that for certain parameter values, the monopolist finds it optimal to continue using the inferior production technology. An implication for welfare purposes is that a durable good monopolist may hold onto a "sleeping patent" when its use is socially desirable. However, we also show that sometimes the monopolist innovates too much relative to the socially optimal level.

Managerial Capital and the Market for CEOs

This paper reconciles two pronounced trends in U.S. corporate governance: the increase in pay levels for top executives, and the increasing prevalence of appointing CEOs through external hiring rather than internal promotions. We propose that these trends reflect a shift in the relative importance of "managerial ability" (transferable across companies) and "firm-specific human capital" (valuable only within the organization). We show that if the supply of workers in the corporate sector is relatively elastic, an increase in the relative importance of managerial ability leads to fewer promotions, more external hires, and an increase in equilibrium average wages for CEOs. We test our model using CEO pay and turnover data from 1970 to 2000. We show that CEO compensation is higher for CEOs hired from outside their firm, and for CEOs in industries where outside hiring is prevalent.CEO pay, CEO turnover, General skills, Firms specific skills

Trust, Social Capital and Economic Development

Many argue that elements of a society s norms, culture or social capital are central to understanding its development.However, these notions have been difficult to capture in economic models.Here we argue that trustworthiness is the economically relevant component of a society s culture and hence comprises its social capital.Individuals are trustworthy when they perform actions they have promised, even if these do not maximize their payoffs.The usual focus on incentive structures in motivating behaviour plays no role here.Instead, we emphasize more deep-seated modes of behaviour and consider that trustworthy agents are socialized to act as they do.To model this socialization, we borrow from a relatively new process of preference evolution pioneered by Bisin and Verdier (2001).The model developed endogenously accounts for social capital and explores its role in the process of economic development.It captures in a simple, formal way the interaction between social capital and the economy s productive process.The results obtained caution against rapid reform, provide an explanation for why late developing countries cannot easily transplant the modes of production that have proved useful in the West, and suggest an explanation for the pattern of reform experiences in ex-communist countries.technological change;public finance;economic development

Work-Related Perks, Agency Problems, and Optimal Incentive Contracts

This paper examines the effects of work-related perks, such as corporate jets and limousines, nice offices, secretarial staff, etc., on the optimal incentive contract. In a linear contracting framework, perks characterized by complementarities between production and consumption improve the trade-off between incentives and insurance that determines the optimal contract for a risk-averse agent. We show that (i) the perk may be offered even if its direct consumption and productivity benefits are offset by its cost; (ii) the perk will be offered for free; (iii) agents in more uncertain production environments will receive more perks; (iv) senior executives should receive both more perks and stronger explicit incentives; and (v) better corporate governance can lead firms to award their CEOs more perks. Our analysis also offers insights into the firms’decisions about how much autonomy they should grant to their employees and about optimal perk provision when managers and workers are organized in teams.Job Perks, Agency Problems, Optimal Incentive Contracts